Hedge fund clone?

Hedge fund clones have already lost credibility. Not surprising for such an absurd idea. Dow Jones says it won't be launching a hedge fund replicator and Goldman Sachs backtracks on the Absolute Return Tracker. No doubt redemptions of $29.5 billion at 1.5% and 20% fees into the "cheap" 1% ART focused minds that cannibalization of GSAM's existing hedge fund business would have been self-destructive. Which hedge funds">hedge funds were clones intending to track? Perhaps some arbitrary, incomplete database of "hedge fund beta" to data mine? There will be human cloning before hedge fund clones and we are a long way from that.

It is hedge fund alpha investors need. The clones' factor lag dependence and the data snooping of REAL hedge fund positions doesn't reassure either. While the rest of us are measuring trade execution latency now in microseconds instead of just plain old milliseconds, clones think they can get away with a MONTH'S delay! The strength of actual hedge funds">hedge funds is their dynamic adaption to market movements and risks. A month late nullifies the chance "cheap" hedge fund replicators have of performing, alpha wise. Being over 2,500,000,000 milliseconds behind the times is a recipe for failure.

Timing was not helped that flagship Goldman Sachs' Global Alpha lost 11.6% YTD. Hopefully no-one is looking to replicate that toxic waste. Investors prefer positive alpha to massive negative alpha and it does not build confidence to see Global Negative Alpha lost money in equities, bonds, currencies and commodities. Losing on all four is difficult to do but somehow the GSAM academic "superstars" managed it. Considering there have been vast alpha generating opportunities within all those asset classes you have to wonder. Was the earlier track record global skill or global luck?

Then there is this aggregation of recent hedge fund holdings to try to feed these clones. Where is this position transparency to "competitors" going to come from? 3 month old, incomplete, long only SEC filings? Monthly reports to clients? Prime brokers? Could it be that some prime brokers are not as rigorous as they could be at ring-fencing knowledge of client positions from the proprietary traders and the hedge fund replication desk? Perhaps the clones will end up copying the weaker hedge funds">hedge funds that provide too much information. But the more disclosure available the less likely a strategy will continue to perform. After the PlusFunds database controversy, one would think competent hedge funds">hedge funds will be even more careful about protecting current AND historical position data from copycats.

One methodology used by the better fundamental equity analysts is comparing a company's value to what it would cost to replicate that business. For example, if you had a spare $150 billion could you replicate Google's brand, people, technology and market share? I doubt it. Bill Gates and Microsoft tried pretty hard. This has a parallel to hedge fund valuation and fees. What would it cost to clone a GOOD alpha generating hedge fund? Simple, somewhere around 2% of AUM and 20% of new profits which gets us back to where we started.

The demand and supply price-setting mechanism works for investment products. Pseudo hedge fund strategies have been available "cheaper" in a mutual fund format for some years at much lower fees AND, of course, much lower performance. As with clones, you get what you pay for. No-one could replicate Renaissance Technologies' Medallion Fund but if you were to try, the fees you would need to charge would be somewhere in the region of 5% of AUM and 44% incentive fee, and even then you wouldn't succeed.

As a way of measuring alternative beta and benchmarking to a naive strategy replication, the hedge fund clones are potentially a valuable industry development. It will also clearly demonstrate just how difficult it is, the hard work and the human and artificial intelligence required to generate consistent absolute returns at low risk. The attack of the clones has weakened before it has even begun and two have already fallen at the first hurdle. The hedge fund replicators' alleged cheapness may prove expensive.

Maybe the attack of the hedge fund clones will prove as mythical as human clones? Geneticists say for every successful cloning you have hundreds of failures. The initial hedge fund clones are starting to look more like the usual marketing spin than a breakthrough financial product. Some say it is dangerous to eat cloned food; maybe investing in these early hedge fund clones will be equally risky, unproven and damaging to the health of portfolios.

by Veryan Allen. Copyright

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